The markets are forcing the hand of policy makers. As usual, they are pushing the policy makers to act. The markets, not surprisingly, always win. Why? Because the business cycle keeps moving inexorably through its phases, as day follows night.
Phase 1. Following 12-24 months of business growth, inflation, commodities, and bond yields move higher. Because of rising costs, business becomes more cautious. The money supply slows down as business borrows less. Liquidity shrinks. The stock market declines. The dollar peaks.
Phase 2. After 12-24 months of slower growth in liquidity, business activity weakens as inventories keep accumulating. Commodities, inflation and bond yields continue to rise. Stocks and the dollar remain weak.
Phase 3. Following 6-12 months of slower growth in the economy, commodities, inflation and bond yields decline. Stocks and the dollar are not declining as rapidly as in Phase 1 and Phase 2.
Phase 4. Business begins to borrow following 3-6 months of lower interest rates, commodities, and inflation. Reason: margins improve as costs decline. Liquidity in the system improves. The stock market and the dollar bottom.
Phase 5. After 12-24 months of growing liquidity, business activity begins to improve. Commodities, inflation, and bond yields continue to decline and eventually stabilize. The stock market and the dollar continue to rise. Go to Phase 1.
Which is the current phase of the business cycle? Phase 1 began in early 2002. At the present time we are going toward the end of Phase 2. The economy has been slowing down, as we expected last year. The next important turning points will be the top in commodities and inflation.
(This Observations appeared in the 3/24/03 issue of The Peter Dag Portfolio)
More details in my The Peter Dag Portfolio , in Dag's Exclusive Market Alert, and my free educational videos on http://www.peterdag.com/.
George Dagnino, PhD
Editor, The Peter Dag Portfolio. Since 1977
2009 Market Timer of the Year by Timer Digest
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